Guernsey: The Implications for Guernsey of the Challenge to its Corporate Tax Regime

Guernsey, along with Jersey and the Isle of Man, is currently
under pressure from the European Union to change what certain
member states consider to be an unacceptable corporate tax regime.
This article looks at the background to this, the alternatives
currently under consideration, and what this might mean for the
island and those that do business with it.

For those of us living in Guernsey listening to judgement being
passed on the island's corporate tax structure is by no means
new. A low tax environment, which those dealing with the
island have enjoyed, has long had its critics, but it has been a
particular issue for the last 10 years. A brief recap of what has
happened in that time will put the current challenge in its proper
context.

It was at the turn of the new millennium that we came under
pressure from the OECD to 'raise tax rates or else', even
if no one was quite sure what the 'else' was. Their concern
was ring fencing, regimes available to non residents but not to
those living here. However, following an unexpected positive
intervention from the US, in the form of Treasury Secretary
O'Neill who felt there was no justification for such external
interference, the OECD drew back. In return Guernsey and other
centres challenged in this way committed to entering Tax
Information Exchange Agreements. The OECD would not intervene in
our domestic tax arrangements as long as they were transparent.

However, no sooner had this threat been removed than it returned
in the form of the EU Code of Conduct Group, which set out to
identify harmful tax practices in the EU and elsewhere. This rather
selective process came up with five in Guernsey.

This time there was to be no white knight, and Guernsey agreed
to abolish these harmful practices, including the exempt company
and international company regimes.

But recognising the need for the island to retain its
competitive position on the international stage, the solution
proffered was a zero rate of tax for all companies (therefore no
ring fencing), with limited exceptions, which included taxing banks
on part of their income at 10 per cent. This was the beginning of
the island's 'zero 10' regime, introduced on 1 January
2008. It was fairly clear even then that this was not what the EU
had had in mind, but it did appear that we had done enough to meet
their demands.

And so, for a short time, peace broke out. There was a brief
period of hysteria later in 2008 when international finance centres
such as Guernsey were being blamed for single-handedly causing the
crisis that spread across the financial world. However, it soon
became clear that this did not do justice to the part played by the
world's banks, particularly in the US, and a review of its own
offshore centres carried out on behalf of the UK Government
supported this more positive view on what places like Guernsey
could offer.

Then, in the autumn of 2009, we were given the news by the UK
Government that, in the view of certain unidentified EU States, our
new corporate tax regime was not in accordance with the spirit of
the EU Code of Conduct and therefore had to change.

Whilst Jersey and the Isle of Man, who were charged with the
same crime, reacted cautiously, Guernsey quickly passed a Bill in
its Parliament authorising a review of its corporate tax regime,
barely after the ink on the previous one had dried. It went on to
clarify that there would be an underlying presumption of a general
rate of tax of 10 per cent, even though the implications of this
had not at that stage been properly thought through.

This was seemingly exactly what the EU had been looking for, and
whilst the zero 10 regimes in Jersey and the Isle of Man are to be
reviewed by the EU Code of Conduct Group, commencing this month,
Guernsey's is not.

However, look a little closer and all is perhaps not as the EU
thought they had seen and you may have heard. Guernsey has made no
final decision on how its corporate tax structure should change,
and has issued a public consultation document, seeking views on the
principles that should underline a new regime and what we see
happening in competing jurisdictions, some of which may well have
been behind the challenge to zero 10.

The document then sets out five options that might be considered
as replacements for zero 10. At the time of writing, the
consultation period is still open but a favourite seems to be
emerging, which is a move to a territorial system of tax, as seen
in Singapore and Hong Kong, and as suggested in the last
Conservative manifesto. A company will be taxed in Guernsey on
income earned, or sourced, here only. This is being seen by many as
best able to address the twin priorities of political and
commercial acceptability. Whilst the former is probably right, it
is a little difficult to be certain, given the lack of clarity
surrounding the concerns raised over zero 10 and the identity of
those behind the move. Commercially it should be workable for many,
although the key to its success would lie in the definition of
'source'.

Of the other four options, the treatment of a company as
transparent, such that its income is taxable in the hands of
individual shareholders does not seem to offer more than the
territorial system and perhaps offers less political
acceptability.

Another alternative in the document is a system of repayable tax
credits, as most frequently associated with Malta and blessed, for
now at least, by the EU. In simple terms this works by taxing the
company at an acceptably high rate but giving much of this back to
a non-Maltese shareholder when they are paid a dividend. In Malta
this process turns the headline rate of tax of 35 per cent to
something closer to five. You might question the longevity of such
an arrangement.

The fourth possibility put forward in the document is a flat
rate, or residence basis of taxation, what might be considered the
traditional way of taxing a company. This is the suggested method
put forward by the Island's government, so it should be
acceptable politically. Whether it is commercially viable, however,
is another matter.

The last option, or more accurately last resort, is to scrap
corporate tax altogether and be just like Bermuda or Cayman - if
not quite as warm. This is a very competitive solution but one that
will further challenge the island's finances. And it does seem
difficult to believe that those who object to our current system
would accept something, which to them is presumably even less in
accordance with the spirit of the code, whatever that means.

The options set out in the document do not encompass all the
possibilities, hybrids and variations that could be considered. We
could even try to resist changing what we have, although that does
seem increasingly unlikely. So the corporate tax regime will
probably change, and there is pressure to introduce a positive rate
of tax, even if that might be considered a contradiction in
terms.

But what does changing the tax system in this way mean for an
island that has built its reputation on being a well regulated but
tax neutral jurisdiction? Would it have a future as an
international finance centre?

The simple answer is that it has to, without this it is very
difficult to see any future for the island at all. There is no one
business or any combination that currently can fill the gap. A
former pillar of the economy, tomato growing will not support an
economy as successful as Guernsey's is now; neither will
tourism. We do have a prosperous e-gaming industry, but a number of
those living here are not entirely comfortable with that and would
be unlikely to support a significant expansion.

And whilst there are many who will not shed a tear if we did
not, and I would include in that some people living in Guernsey, I
sense a growing determination within the island to meet this
challenge, knowing, again, there will be no Paul O'Neill to
come to our rescue.

It is acknowledged that the current uncertainty over the
Island's corporate tax regime is not good for business. Whilst
those already here will give us time to resolve it, it must be a
deterrent to those looking for a tax neutral location to move to or
do business with. To an extent this uncertainty has been
replaced by the perception of a broad based 10 per cent tax rate,
which is not helpful either. However, if the process is properly
managed from here, it should be to the island's long term
benefit.

For those individuals looking to move to Guernsey, which has
many attractions over and above its favourable personal tax regime,
this should in any case not be an issue. Even those that buy an
open market property should be insulated by the law of supply and
demand from any threat this might cause.

For business, whilst the uncertainty is not ideal and mistakes
have been made in getting us to this point, a workable solution
will be found. It has to be. Funds established here will remain tax
exempt. Whether we eventually keep zero 10 or change to, for
example, a territorial system, most doing business with the island
should still be able to enjoy that tax neutrality which has been a
feature of Guernsey as an International Finance Centre for so long.
And whilst this work goes on, Guernsey most definitely remains open
for business.

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